Question

Assume that you are an intern with the Brayton Company, and you have collected the following data: The yield on the company's outstanding bonds is 7.75%; its tax rate is 25%; the next expected dividend is $0.65 a share; the dividend is expected to grow at a constant rate of 6.00% a year; the price of the stock is $15.00 per share; the flotation cost for selling new shares is F= 5%; and the target capital structure is 25% debt and 75% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget?
a. 6.89%
b. 7.24%
c. 7.64%
d. 8.55%
e. 8.44%

Answer 1

Answer:

WACC is 9.37%

Explanation:

After tax cost of debt=yield to maturity*(1-t)

where t is the tax rate of 25% or 0.25

after tax cost of debt=7.75%*(1-0.25)=5.81%

Using stock price formula,the cost of equity can be determined as below:

stock price=Di/k-g

Di is the next dividend of $0.65

k is the cost of equity which is unknown

g is the constant growth rate of 6.00%

stock price=$15*(1-f)

f is the flotation cost percentage

stock price=$15*(1-5%)=$14.25

14.25=0.65/k-6%

14.25(k-6%)=0.65

k-6%=0.65/14.25

k=(0.65/14.25)+6%=10.56%

WACC=Ke*We+Kd*Wd

ke is 10.56%

We is the weight of equity which is 75%

Kd is 5.81%

We is the weight of debt which is 25%

WACC==(10.56%*75%)+(5.81%*25%)=9.37%